Islamic banking – concepts and constraints

Islam is not only concerned with the relationship between man and God but is also a system of beliefs. Justice, equity, fairness and morality are values which underpin the entire Islamic way of life, of which commerce is only a part. These beliefs are governed by the body of Islamic jurisprudence generally referred to as Shariah. This law is derived from various sources and is open to different interpretations. Accordingly, many financial institutions have a religious board or a Shariah adviser to ensure compliance with the principles of Shariah and to provide an opinion, or fatwa, when required.

These principles include:

Interest

The charging of any interest, or riba, is strictly prohibited – any return on money employed should be linked with the profits of an enterprise. The concept of riba extends beyond interest and usury, and although it was not given a precise definition by the Prophet Muhammad, it can perhaps best be described in terms of a prohibition of exploitation by one party who owns a product that includes money or capital and which another party wishes to acquire. Whilst interest is the classic example of this, it is probably better to think in terms of unfair exploitation.

Speculation

The Shariah does not permit speculation or gambling, or maisir. As a result, many Islamic financial institutions feel unable to enter into derivative transactions such as swaps, futures, options or contracts that insure for a profit.

Prohibited investments

Investments involving certain products, such as pork, alcohol or armaments, and activities such as gambling, are prohibited. Islamic institutions may (depending on the view taken by their Shariah committees) encounter difficulties with investments in businesses such as hotels and the entertainment industry.

Profit

Profit cannot be assured and an Islamic financial institution must assume at least part of the risk of a given transaction. There can be no guarantee of a fixed return. Equally, depositors with Islamic institutions may not invest on the basis of a guaranteed return. However, taking security is permitted in order to guard against negligence, wilful wrongdoing or breach of contract by parties to the contract.

Uncertainty

The existence of uncertainty, or gharar, in a contract is also prohibited as it requires the occurrence of an event which may not occur. When entering into a contractual relationship, there must be “full disclosure” by both parties because a transaction which is tainted with gharar will not be permitted. Any type of transaction where the subject matter, the price or both are not determined and fixed in advance will be viewed with suspicion under Shariah law.

Hoarding

Trade and enterprise, which can generate real wealth for the benefit of the community as a whole, are encouraged between partners sharing profits and losses. Hoarding money is improper; money is merely a means of exchange and should not be treated as a commodity.